Real estate matters a lot to China: Property construction and sales have been the main drivers of economic growth since President Xi Jinping came to power a decade ago. House prices have soared – up sixfold over the past 15 years – as an emerging middle class flocked to property as one of the few safe investments available. The boom led to speculative buying as new homes were pre-sold by property developers who increasingly looked to international investors for funds. So when Chinese authorities took steps to reduce bubble risk and temper the inequality that unaffordable housing can create, it sparked a crisis that put some major developers in default. A sales slump that began during the pandemic has been compounded by aggressive measures to contain Covid-19. So far, state intervention has prevented a disorderly collapse in the housing market that could undermine the financial system and also shake the global economy.
How Chinese property developers got into such a mess
1. What fueled the housing boom?
In 1998, when China created a national housing market after severely restricting private sales for decades, only a third of its population lived in cities. Today nearly two-thirds do, increasing the urban population by 480 million. The real estate sector has also grown rapidly, while struggling to keep up. Booming cities such as Shenzhen have become less affordable on a price-to-income ratio basis than London or New York, frustrating a generation of potential buyers. Local and regional authorities, which depend on public land sales for much of their revenue, have encouraged more development, which has also helped to meet the central government’s ambitious annual targets for economic growth, which often reached the two digits. Debt piled up as builders rushed to meet demand. Annual sales of offshore bonds denominated in dollars – that is, those sold primarily to foreign investors – fell from $675 million in 2009 to $64.7 billion in 2020, resulting in a charge of growing interests. The sponsors had some $207 billion in dollar-denominated bonds outstanding at the end of last year, which is about a quarter of the total of all Chinese borrowers. Additional and opaque liabilities make it difficult to assess true credit risks.
2. What did the government do?
For years he tried to defuse the debt bomb, fearing an explosion could trigger a disastrous financial collapse. In mid-2020, he began securing new funding for property developers to try to reduce the threat, and asked banks to slow the pace of mortgage lending. The new borrowing measures introduced for developers proved to be a game-changer. Called the “three red lines” by state media, they aimed to reduce reckless borrowing by setting thresholds for liabilities, debts and a promoter’s cash. Annual borrowing would be capped based on the number of parameters met.
3. What happened to the developers?
Those who did not have enough cash to cover their debts found themselves in a bind. At least 18 defaulted on offshore bonds after the crackdown began. China Evergrande Group, once the country’s biggest developer, was first categorized as defaulter in December after missing payments on several bonds. The establishment of a “risk management committee” dominated by provincial officials was quickly announced to prevent the company from a complete collapse. (Bondholders were still wondering how much they would collect once the dust settled.) Others, including Kaisa Group Holdings Ltd. and Sunac China Holdings Ltd., followed. Fears of further contagion reverberated through industry and the wider economy, hammering domestic growth, weakening consumer confidence and rattling global markets that have long assumed China’s property titans would be bailed out by the government.
4. Where does this leave the industry?
In a deep slump. The combined sales of the top 100 developers have halved in the first four months of this year compared to last year. Home loan growth slowed to its weakest pace in more than two decades at the end of March. Construction fell 14% in 2021 from a year earlier, the biggest drop in six years. All this matters a lot because in China, the real estate sector accounts for almost a quarter of the gross domestic product, if we include non-residential construction, building materials and related activities such as real estate services.
Across China, millions of square feet of unfinished apartments have been left to dust due to developers’ cash flow problems. Home prices began to fall in September for the first time in six years. A full-scale real estate crisis could leave millions of additional buyers who put money up front in limbo. (Buyer protections commonly used overseas, such as escrow accounts and installment payments, tend to be weak.) Fire sales would further crush the market, crushing other developers and rippling through industries and related suppliers. The risk of popular unrest – more than 70% of urban China’s wealth is stored in housing – would increase, disrupting the government. A historic offshore bond sell-off would ripple through the much larger domestic credit market, moving from lower-rated real estate companies to stronger peers and banks. Global investors would sell even more.
The government has tweaked some rules to try to stabilize the situation. For example, the central bank has stepped up support for several struggling developers and banks have been instructed to ensure growth in residential mortgages and developer lending in certain regions. Above all, avoiding a “Lehman moment” – when the US bank failure in 2008 sent shockwaves through global markets – is a priority ahead of this year’s Communist Party congress, where Xi is expected to be given a third mandate. This political necessity most likely means that the government will try to contain the crisis, at least in the short term.
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